Robert R. Prechter, Jr.
Author and CEO of Elliott Wave International
"Conquer the Crash: You Can Prosper and Survive the Coming Deflationary Depression"
Transcription of Audio Interview, June 1, 2002
Editor's Note: We have edited the interview in this transcription for clarity
and readability.
The original real audio interview
may be heard on our Ask The
Expert page.
JIM PUPLAVA: Joining me on the program is Robert R. Prechter, Jr. Bob first heard about the Wave Principle back in the 1960s as an undergraduate studying psychology at Yale. While working as a Technical Market Specialist at Merrill Lynch in New York in the mid 1970s, he located the only available copies of R.N. Elliott’s original books in a New York library. He also wrote, with A. J. Frost, Elliott Wave Principle, Key to Market Behavior. Over the next two years, he started The Elliott Wave Theorist, a publication devoted to the analysis of the U.S. financial markets. During the 1980s, Prechter won numerous awards for market timing as well as the United States Trading Championship, culminating in Financial News Network, which is now CNBC, granting him the title “Guru of the Decade.� In 1991, he was elected and served as the president of the national Market Technician’s Association. He has written numerous books, including At the Crest of the Tidal Wave and The Wave Principle of Human Social Behavior Today we are going to talk about his new book, Conquer the Crash: You Can Survive and Prosper in a Deflationary Depression.
Bob, back in November 1978, with the DOW at 790, you predicted a great bull market ahead. You were well ahead of everybody else at the time, and you saw it sooner than most people. To your credit, you also got out, but you admit that you got out too early. What did you see back in 1978, and what are you seeing now, that makes you hesitant about the market?
ROBERT PRECHTER: Well, we saw a lot of things in 1978. The main one was a bullish picture from the Wave Principle -- the long-term pattern in Dow Jones Industrials going back to 1932. Of course, all of the practitioners of the Wave Principle since R.N. Elliott had labeled the waves in real time essentially the same way. It was really a matter of saying, “Now is the time.� There were other elements that helped a lot. One of them was the feeling of crisis in the late �70s. Inflation was running away, bond prices were falling, and we had several recessions in a row. That kind of background gives you a good base of fear, which means that people who are invested in stocks tend to lighten up because they feel that the only way they can go is down. There were many psychological measures saying the same thing. That’s terrific support for a bullish wave expectation because when people are mostly out of the market, as they were in the late �70s and early �80s, it means that if the trend changes or psychology changes, it’s going to change for the better. So that was the backdrop for that situation.
JIM: In the preface to your book, Conquer the Crash, you’ve got a warning. You said, “I’ve been wrong before,� and I want to give you credit for admitting that -- very few people can. But what’s the downside risk, if you’re wrong about a recession or a depression and crash?
BOB: Well, I tried to formulate a strategy so that, no matter what happened in the market, people who took the strategy wouldn’t lose money. We’ve got an extremely safe portfolio suggestion in the book, and that’s of course, if you’re not really motivated to seek profits in a bear market. But I would really suggest to your readers who’ve been around awhile that bear markets are much swifter than bull markets. They cover territory a lot faster. So if you can take one of the half a dozen ways I suggest in the book for making money on the downside, you should do that. One of the suggestions I have is a way that you can make money no matter which direction the market goes, and that’s very attractive to me.
JIM: There was a great stock market trader by the name of Jesse Livermore, and that was the one thing he always said. He didn’t care which direction the market was going. He’d be short just as easily as he could go long. He made a lot of money going short. In fact, I think he made something like a hundred million on the day that the stock market crashed. So, as you point out in your recommendations, it's also a great way to make some money.
BOB: I would like to add one thing. I think it’s wrong for people to conceive of the market going either up or down. Every one of these indexes that we’re watching is nothing but a ratio. It could be stock shares per dollar. If you invert it, you get dollars per stock share. It all depends on whether you want to be long the stock market or long dollars. Those who trade currencies know this. If you’re tracking the yen, it’s either the yen in terms of dollars or dollars in terms of yen. Depending on which country you’re in, you can call it a bull market or a bear market with the exact same changes in price. People need to reorient to the fact that, if they’re only comfortable with rising trends, they should flip the ratio around and say O.K., now my dollars are going up in price relative to stocks.
JIM: Let’s talk about this book, which you’ve broken up into two parts. The first part is why you feel there will be a stock market crash, monetary deflation and an economic depression. In the second part, you talk about how to protect yourself from deflation and depression. Let’s start with the case for a crash and depression. Why a crash and a depression?
BOB: I think the main tipoff that we’re there already -- of course there are several, and I detail them all in the book -- but the main one is that we’ve reached an extreme valuation on the upside in stock prices and then reversed. Each time that an extreme anywhere near what we have has happened in the last 300 years -- and of course the recent one is much more extreme than any of those in the previous 300 years -- the decline in the stock market thereafter brings out a severe contraction in the economy. The reason is that the public gets involved in the stock market at those times. There was a poll done in 1952 and another one done in 1982. They found that less than 10% of the public was involved in the stock market. Of course today, that’s up to 50% or 60%, depending on how you count it. This means that many people have their fortunes wrapped up in stock prices. When they come down, it means that many more people are going to suffer as a result, and I don’t mean just suffer financially but economically as well.
JIM: Let’s begin with this myth of the new era. You identify very well in your opening chapter of this book the economic myth that we've had of a new era with superb economic growth and earnings. Address that issue, because a lot of people have not seen through it yet.
BOB: The famous “new economy,� right? The first graph in the whole book is a lot of fun. It shows the number of times in news articles that the term “new economy� appeared in the news worldwide. Of course, it peaks out in the year 2000, with over 4000 mentions of the “new economy.� So it was a really hot topic in 2000. The question is, does the emperor have any clothes on? And we find out that he really didn’t. The talk of the new economy was engendered almost entirely by psychology and the optimism and ebullience that was going on. It was independent of the stock market, but it showed up in the stock market. What we didn’t have, in actuality, was a new economy. All you have to do is look at the figures and compare those powerful bull market years from 1974 to 2000 with an equivalent time period of rising stock prices from 1942 to 1966. We found out that, in every case (and some of these numbers are very interesting), what we call the fifth wave -- the rise from 1974 -- was weaker from gross domestic product to industrial production, capacity utilization, the unemployment rate and right through to all the measures of debt and liquidity and interest rates. We had a much stronger period in the 1940s and 1950s into the early 1960s than we did from the mid-1970s until the year 2000. It’s clear, across the board, in all of these figures. So, my question is, where is the new economy? And the answer is, we didn’t have one.
JIM: That was very clearly stated in your book. You also showed charts. We've got this myth -- maybe it was helped along by the financial media -- of companies beating expectations with superb profits. There is a falseness to some of these numbers. But I want to go on and talk about something that’s very different today. That is the level of debt. We heard all these wonderful stories in the �90s about the government paying down the deficit -- and that’s a story in itself -- but corporate debt went up and consumer debt levels went up as a percentage of GDP. We’ve got installment debt, credit card debt at record levels, corporate debt at record levels and more surprising, and going along with that, we have a negative savings rate. I wonder if you might address how these conditions spell an end to a boom, because you can’t borrow your way to prosperity.
BOB: I think you hit the nail on the head. Here are some of the figures that you were talking about. During that third wave, from 1942 to 1966, consumer debt was only 64% of annual disposable personal income on average. At the end of the fifth wave in the year 2000, it was 97%, and as you point out, right now, it’s over 100%. So debt is greater than annual disposable income. We had total credit market debt at 150% of GDP back in the third wave. It’s 300% today -- double that amount. So three times annual GDP is what we owe. I think this is fascinating. The prime rate was 3.75% on average during the 1942 to 1966 period. It was just under 10% on average between 1974 and 2000. That to me -- and we’re going to get to that later in our discussion I hope -- is the big problem. It’s one thing to have an unprecedented amount of debt outstanding, but it’s another to have that debt saddled with a high real rate of interest, because that rate of interest is larger than the economy can produce.
JIM: This is one reason why we don’t see real bottom-line numbers of companies discussed any more. One of the real profit killers, at least from what I’ve seen from a fundamental point of view, is this record amount of corporate debt and rising interest rates. That interest expense is just killing and decimating corporate profits�.
BOB: Except for the banks.
JIM: Yeah, well, they’re making money on this, but for how long?
BOB: Exactly.
JIM: I want to talk about this debt situation. They release this number every month. Let's take personal income and personal expenses for the month of April. Personal income went up 3/10 of a percent, and yet personal spending went up 5/10 of a percent. They never talk about that as being negative. That tells me that Americans are increasingly relying on debt to support their lifestyles.
BOB: When I did the research for this book, I found an amazing fact. Do you know there are two very solid countries in the world, where the finances are strong and the government has very little debt, where the citizens are saving 25% of their annual income or more, and in one of these countries it has gone up to 40% occasionally? Here in the United States, as your statistics just revealed, we have a negative savings rate. On average, people are spending more than they’re making. Where is it coming from? They’re borrowing, and they’re also pulling it out of whatever savings they have left.
JIM: That’s why when I see these economists talking about these 3% and 5% growth rates for the economy in the 2nd half and then this miracle of corporate earnings going up 30% and 40%, I wonder what they are looking at. I mean, do consumers go out and go into a minus 5% or minus 6% savings rate? I just don’t think that’s going to happen.
BOB: I think most of that, although they would never admit it, is from hope. Because they say the only way that the stock market can hold up -- and the only way that any of this debt can get paid off -- is if corporate earnings start soaring and people’s incomes start soaring at some massive double-digit rate. So they’re saying, “Well, I guess that’s what’s going to happen.� I think the burden of debt is piled up so high that it’s not only impossible, but that is the reason why we need to be looking in the other direction.
JIM: Let’s address the issue of these rising interest rates in comparison, let’s say, to previous boom periods. Today we have corporate debt valued at about 60% of total assets on the balance sheet. You’ve got consumer debt valued at over 100% of disposable income, and this is all occurring, Bob, at a time when interest rates are not only high but also in the process of rising. Let’s address that issue in terms of what it portends for the economy and the markets ahead.
BOB: Well, in and of itself, a rising interest rate is not necessarily really negative. We had a steadily rising interest rate throughout the 1970s, but at the time, it was chasing inflation. Today when you look at the PPI and the CPI and other measures of goods prices, you find no inflation in those areas. The money is going into the investment areas. The problem is not just rising rates, but rising real interest rates against in a slowing economy. We just talked about the slowing in the economy during the �80s and �90s compared to the �50s and �60s, but we’ve also had a slowing even in the �90s themselves versus the �80s and then again in the last few years of the �90s compared to the earlier �90s. Profit growth was averaging almost 11% in the �80s. It was averaging 8.8% in the �90s and in the last few years only 4.5%. So you can see that the economy’s been slowing all the way. Not only do I think that the rising burden of interest was slowing the economy, but there was also a focus on finance instead of production. People thought they could get rich manipulating stock shares and debt and that sort of thing instead of actually producing goods. Now you’ve got an economy that’s producing at a very slow rate and yet the burden of interest is high. That’s a double train wreck. That’s two trains heading toward each other at 90 miles an hour.
JIM: Isn’t there also a problem with the fact that during the �90s, many industrial companies -- like IBM or General Electric -- morphed themselves into finance companies? They were making more money on finance than they were by actually making things.
BOB: Oh, yeah. General Electric, for example, transformed itself from perhaps the premier manufacturing company in the world in the 1950s and �60s to what I call a house of cards right now. It’s all about manipulating credit, manipulating debt. They’re lending, they’re borrowing, they’re shifting money around, they’re shifting credit around. We put out a special chart on General Electric in the first days of October 2000 and said, “This bull market is over. The stock is up 100 times from its low in 1974, and it’s over.� It’s since been cut in half, and frankly, I think it’s just the beginning. GE is not Enron, but it is that type of financial company where, ultimately, the trend in finance and investments is going to be the trend in that company’s fortunes. It will be a slower decline than Enron’s, and there’s certainly less in the way of accounting gimmicks, but it uses them anyway, and people have noticed it. I think it’s going to take a long time for GE to return to a solid company that’s producing things that people really want.
JIM: Now, in your book, Conquer the Crash, you’ve drawn a lot of similarities to the U.S. in the 1920s and a similar experience in Japan. I want you to comment on those two.
BOB: Well, this is crucial because a lot of people might be listening and saying, "Well, so what if the economy has slowed down for the last 50 years? We don’t know what that means." The truth is, we know exactly what it means. The last time in this country that we had an economy that expanded at a lesser rate than a previous period in the midst of a huge stock boom was the 1920s. During that period, GNP increased 48%, but several decades earlier we had a boom with not very much going on in the stock market but the economy was really cooking at a 68% gain. So in the 1920s, you had the slower economy against an overheated stock market. That’s exactly what we’ve had this time around. But, to me, the most interesting example is Japan because it’s not ancient history, and as every economist will tell you, anything before WWII doesn’t count. Well, Japan had a “miracle� economy, or so people told us, in the 1980s. Again, the Japanese miracle was mostly a story of stock prices going wild just as we had in the United States in the �90s. But, what they don’t tell you, and what I had never seen mentioned, was the fact that the real growth in GDP in Japan during that crazy stock boom, from 1974 to 1989, was only 4%. From the mid 1950s to the mid 1970s, it was more than double that at 9.4%. So the real growth came back in the �50s and �60s for Japan. There was lesser growth in the �80s, but that’s when the stock boom occurred. We show the difference in a chart right in Chapter 1. So now we have two terrific historical examples of what happens when an economy and a stock market experience exactly what we went through in the 1990s.
JIM: In your book, you talk about depressions. When do depressions occur and what causes them?
BOB: Well, a depression occurs when the economy contracts severely, which happens when there is a sharp decline in the demand for goods and services at current prices. We are facing exactly that sort of thing today because people can’t save, and they’re spending more than they’re making, so we know that they’re going to have to cut back on their spending eventually. When people are trying to pay off debts at a very high rate of interest and their income slips -- and as we’ve been seeing, unemployment has been edging up to new highs with each passing quarter -- they’re going to do less spending as well. So I expect to see a decline in the demand for goods and services in this country. That is going to be the beginning of a depression.
JIM: During the �30s, as this decline in demand was experienced throughout the economy, the government came in with the New Deal and tried to establish programs that would support or uphold that demand. A lot of people are saying today that because of all the safety nets, and because the government is involved in the economy, a depression can’t happen here. How would you argue against that?
BOB: I think that it’s difficult for most people to get their hands around this issue because there’s so much rhetoric that’s misleading about government efforts to do anything in the economy. A free economy is the best economy, and anything that the government does always provides a result that hurts the economy in the long run. Sometimes people think that there are short-run benefits and they can point to them. Usually, even on the short run, the only reason you can see benefits in some areas is because other areas are being hurt. Governments are always late to react, so they’re certainly not going to prevent anything. When they do react, they usually do something destructive. So none of those solutions are going to help. If you need any recent guide to tell you how much the government’s on the ball, just ask yourself, did any of these agencies tell you that Enron was about to go bankrupt? The answer is no, they haven’t got a clue, and they certainly aren’t going to know in advance what the economy is going to do on the downside. You need to protect yourself. That’s why this book is called Conquer the Crash. I want people to take their finances in their own hands and not be victims of what is already developing.
JIM: Where do we stand today in terms of depression?
BOB: I think it’s just started. The peak in the stock market was the first quarter of 2000. We had some averages -- only two -- actually peak last month, in April, along with one Dow stock, triple M. All the other Dow stocks had already topped out. That was the last one to go, in our opinion. If your listeners know about that famous technical pattern called a “head and shoulders top,� the S&P made a left shoulder in 1998, it made the head in early 2000, and the rally up from September of 2001, right after the 9/11 attack, has been the right shoulder. We’re now rolling over on that, so we’re due to be heading down quite relentlessly. I think it’s already started.
JIM: What are the signs of this topping stock market? You just mentioned the “head and shoulders� pattern, but give some of the other signs that a market is topped. We can talk about market valuations. But what are some of the other more prominent signs?
BOB: Well, to me, the most important one is the wave pattern. The biggest signal that the bear market is underway was the five wave decline in the S&P 500 and the NASDAQ index from March 2000 to September 2001. Those patterns are unmistakable. They say in no uncertain terms that the major trend is now down. In fact, it was on 9/11 that I published a special issue and that said, "Don’t panic here, even though everybody else is going to say this incident could kill the stock market. We are right near the end of five waves down and we’re about to have the biggest rally since the bottom." And that’s exactly what happened. But that rally is probably over now. It gave you a terrific opportunity to get out if you were one of those people who said, "Give me proof." You had the proof � 5 waves down and 3 waves up -- and now you need to be on the sidelines. So the Elliott wave structure is number one.
Psychology is number two, and this is crucially important. Generally in a bull market, when there’s a reaction against the long term uptrend, people turn bearish. When a bear market begins and you get that first leg down, instead of turning bearish like they did in the corrections on the way up, they welcome it as a buying opportunity. You can see this happening today in all kinds of indicators, which show that we’ve seen an increase in optimism from September, not skepticism. If we’d seen skepticism, we would suspect that the market would be ready to keep going up. But we saw people put more money into the market. And boy, that shows up in all kinds of things -- from the P/E ratio to the consumer sentiment index.
JIM: Let’s talk about some of the market valuations. I find it amusing that Wall Street, which has all these brilliant analysts, people that have gone to school, have studied finance and accounting, doesn’t seem to know at least a little bit about market history. But if we take a look at the price to earnings ratio -- which is a little bit suspect -- the price to book ratio, dividend yields, anything that you would look at in terms of measuring the market in terms of whether it’s cheap or expensive, this is a very expensive market. So I don’t know where they expect this market to recover from or to go -- to even more extremes?
BOB: That’s a good question. For example, let’s do just three in a row very quickly. The dividend yield on the Dow got down to 1.5% in early 2000. In 1929, at the top minute before the biggest crash in the history of the United States, the Dow was yielding just under 3%. So here we’ve gotten down to half that level, and, of course, that means that your real income from dividends is zero by the time you’ve paid your transaction costs or your money managers. And that’s in the Dow, where the yield was comparatively high. In the S&P 400 Industrials, it was only 1%. In the NASDAQ, it was virtually zero, so you were essentially paying fees for the privilege of owning NASDAQ stocks. This is an extreme to say the least.
I try to teach people one very important thing that gets overlooked in the later stages of bull markets, and that is that dividends are the only reason to own stocks. If nobody is ever going to pay you a nickel from that company, why would you want to own any of it? You’re just making the CEOs rich and everybody else, there’s no point. Now, a couple of other measures of valuation --the bond yield/stock yield ratio, for example, which Paul Montgomery developed, shows you how much more high-grade corporate bonds were yielding than high-grade stocks because people didn’t care about getting a dividend yield. It got up to 8 times at the March 2000 high. Also, the book value of the S&P 400 was extremely low. Price was 10 times book at that peak. The amazing thing is that at previous major tops it was only 2 times. So this is not just any old top. We haven’t just seen something like 1966 or 1973. This is a monster. This is one that the next Charles McKay will be writing about in a history book.
I guess the last one we should mention is the P/E ratio. I spend several pages on this in the book because it’s a very subtle point to be made, which I think -- I hope -- the readers of it will find very interesting. But let’s just say that on a superficial level, markets tend to peak out when the P/E ratio is in the low 20s, meaning 20 times 12-month trailing earnings. And right now, it’s about 50. So prices are going to have to be cut in half even to get them back to where a normal bull market normally tops.
JIM: Speaking of P/E ratios, what I call earnings obfuscation because some of the numbers that are being bandied about as “this company beat estimates� or “this company’s earnings grew��we’re not talking, Bob, about earnings in the traditional sense, in other words, the bottom line. What is thrown out there as earnings today can have any number of different meanings. They’re not talking about the bottom line as you and I know from an accounting point of view. It seems like there’s this game that’s being played where you had -- and I’m not picking on a particular company -- but we had Applied Materials announce its earnings, and they beat earnings by a penny! I think they made 3 cents instead of estimates of 2 cents. But their sales were down 46%! Their earnings were down 84%! And their profit margins were down 13%! Now, if you listen to the commentator say that they beat estimates, it sounds as if things were doing well. In reality, they were doing poorly.
BOB: Exactly. You know, lawyers made a lot of money in the 1990s being called in at the eleventh hour, in the final week, let’s say, before a company had to report its earnings, and being asked, "How can we juggle these numbers in order to show a little bit higher earnings than we had in the last reporting period?" There are so many things to say about this. Let’s forget for a moment that manipulation itself is a little bit like lying to the public, and let’s say that it’s legal and that everything they did was fine. A lot of times, for example, they would buy back their own stock in order to get the earnings per share up. The real point to me is always psychological. I thought this was an amazing phenomenon. Here people are buying stocks, not based on what the earnings are compared to the stock price or compared to the size of the company or compared to what they ought to be earning. It was simply a matter of, “Did they earn more than they did last year? Oh good, let’s buy some more!� Do you realize there was actually a time in history when that happened before? It was in the late 1920s, and the people who wrote that up were none other than Graham and Dodd. I published that as an issue of the Elliott Wave Theorist and as a chapter in a book I recently put out called Market Analysis for the New Millennium. It just shows you, there’s nothing new under the sun.
JIM: Of course, the public psychology. Even, I believe, in 1930, there were comments coming from government officials, prominent economists and Wall Street gurus of that time trying to reassure the public that the best was just ahead and the market was going to come back. And we see this very same thing going on today.
BOB: Yes, and I think your choice of time there is right where we are today. We’ve had the initial crash. Although it was a slow one, it was a NASDAQ collapse of 75%. We’ve had the rally since September, which is very much like the rally between November of 1929 and April 1930. I think, once again, that the market probably peaked out in April and is ready, or has already begun, to head lower. And what do you see? You see generally the economists and government officials and people like that telling you everything is fine. There are a few mavericks out there who think well, maybe we’ll have a “W� or “double dip� recession. You know, we’ll go down and have a little softness later in the year, and then we’ll be taking off. One of the great ironies is that late last year, the consensus among economists was that the economy would bottom at the end of the first quarter, and I think it topped at the end of the first quarter.
JIM: Now, what about this proposition put forth by Wall Street that the Fed has aggressively cut interest rates and somehow -- it’s called the “Greenspan Put� -- that the Fed has put a floor underneath the market? Why don’t you tell our listeners why the Fed is not going to be able to stop this.
BOB: Well, first of all is the fact that interest rates collapsed. The Fed was right there as fast possible to do its part. Rates fell dramatically throughout the entire year of 2001. This is not good news. This is terrible news for two reasons. Number one, it indicates that deflation is around the corner -- and we’ll be talking about that in a minute. The other thing is, if you really believe that the Fed has the power, has the ammunition, to regenerate an economy by lowering interest rates, they’re already under 2%, and as I say in the book, "What’s next?� What’s the next rabbit it can pull out of the hat? It might be able to bring rates down to near zero. But Japan did that years ago, and it didn’t stop their decline, didn’t stop their deflation, didn’t stop their rolling recessions. So, this is not good news. Essentially, it means that the guys in the fort that are supposed to be out there fighting for you just ran out of ammunition.
JIM: Given the fact that in the first part of your book you talk about the crash, the depression and deflation, let’s move on to part two and how to protect yourself. I want to address the issue of deflation because you talk about that being the key investment risk. So, let’s begin there.
BOB: Very few people know anything about deflation, and there are two reasons. Number one is that in the 19th century, we would have them quite often, so people could get to know what a deflation was. You’d have an expansion for 2 1/2 years, and you’d have a contraction for 1 1/2 years. Then you’d have another expansion for a year or two and another minor contraction. It was a very healthy economy because it does what I call “breathing.� It would expand and contract normally. If you’re a business person, once you had gone through three or four of those, you’d say, "Okay, I get it," and you could plan around those things. What we’ve had since the Fed was created is a climate of massive boom and tremendous bust. We had one boom right after the Fed was created in 1913 that lasted to 1929, and then we had the incredible collapse over the next four years into the depression lows of 1933. Ever since then, we’ve had nothing but inflation and expansion, right from 1933 to the present. Deflation now is outside not just the memories of people who are alive today, but you’d have to go back to their grandfathers, who are mostly deceased, in order to bring stories of deflation to light. So most people today don’t even know what you’re talking about when you talk about deflation. To summarize it, a deflation is a contraction in the total supply of money and credit. When that happens, the nominal prices for virtually everything, from stocks to bonds to commodities, go down. Even consumer goods go down in price in a severe deflation. That’s what I believe we are facing today.
JIM: Let’s talk about an investment that is being bandied about as a good place to be right now, which is the bond market, because of lower interest rates or lower economic growth. Explain to our listeners why bonds can get hurt in a deflationary environment.
BOB: There are two types of bonds. Bonds that have been issued by such strong issuers that there’s no question that both interest and principal will be paid, that’s one group. The other group of bonds are those issued by entities that are questionable as to whether they will pay all of the interest due and all of the principal. The questionable end of the market is by far the largest. I would say that probably encompasses 95% of the debt outstanding today. That’s corporate, individual, governmental, including municipal, around the world. We’ve already seen major countries in trouble trying just to pay the interest. Forget the principal on the debt. So, if you observe the interest rate of bonds from these pristine debtors who are in terrific shape, you’ll see that the interest rates are low. There’s no really serious price erosion. As for all the other bonds, at some point during the depression, their holders begin to wonder, worry and eventually panic over whether what is owed will eventually be paid off. If you’re privy to any junk bond chart, you can see that the prices of junk bonds have been falling pretty relentlessly for the past 12 years. Now it’s beginning to spill over into the medium-tier bonds issued by corporations. I think this is a smart market. I think this is the bond market beginning to realize what my book is all about, that we’re heading into a depression. People need to get out of them before everyone else realizes it.
JIM: Speaking of quality bonds, there are very few corporations today that carry a AAA rating. As I recall, there are only about 7 or 8 of them.
BOB: Yes, and the worst of it is, how do you know that those ratings will remain AAA? They’re rated that way under the current economy, and if this economy gets weaker, which I’m positive it will, those ratings are likely to slip below AAA. But that’s an amazing statistic. I need to add that to my book.
JIM: Let’s talk about one of the last pillars, in my mind, that is still holding up this market. To me, the bubble in the stock market simply found another place to land -- which is real estate. We had this boom. In fact I just read an article today where somebody was disputing whether this is a bubble, saying it’s just a huge demand. The individual that wrote this article said that real estate prices would remain high because government entities are making it hard for new development due to urban sprawl. They’re trying to contain it, and that’s going to maintain the price of real estate. I see this as the next bubble to pop. And once that does, that’s it.
BOB: I agree with you, and I think bubble is the correct term. Demand is one thing. There can be a tremendous demand for bread and milk out of the grocery store when a hurricane’s coming. But people don’t go out and systematically, decade after decade, borrow more money to buy bread and milk, as they do to purchase real estate. The reason they do this is for two reasons. Number one, they want to consume something today that they haven’t saved for. And the second reason is, they believe that the price always goes up, so they’re willing to take a tremendous risk of debt in order to own something that they believe will continue to rise. The problem is that every so often -- and it isn’t that often, but it does happen, and when it does happen, it’s very devastating -- real estate prices go down, and they go down severely. The last time that we had anything like what I’m looking for here was in the early 1930s, and prior to that was the early 1840s. We’ve had 8 episodes of severe real estate drops in the past 200 years, and I think we’re heading into our 9th one right now.
JIM: Why is cash important in the midst of deflation or a depression?
BOB: Well, cash is the only thing that assuredly goes up in value during deflation. The reason is the credit -- which is considered by most people to be money, although it’s actually credit -- begins to decrease, and therefore the total amount of purchasing power in the economy goes down. Any time that the credit supply �which people loosely call the money supply � contracts, there’s less purchasing power in the economy. People can understand that when the government creates money and the Fed creates credit, and there’s more and more of it, we get inflation, and the value of the dollar, or the purchasing unit, goes down. Therefore, prices of goods go up and up. People are used to that. They have to realize that it can work in the other direction. When the total amount of money and credit contracts, the prices of goods will actually start falling, and that makes each unit of money -- each unit of money or credit that survives that is -- worth more. The key is to be in money or credit that will not be destroyed. If you own a bond of a corporation or a municipal government that defaults, you’re at zero. But if you have money that does not disappear, then suddenly you have more buying power than you did before. A lot of my book is designed to steer people into areas where they will be able to put their cash and keep it safe. And believe me, there aren’t many places in the world. A lot of places that people think their money is safe are anything but.
JIM: I want to talk about safe banks. Certainly, people know about the bank holiday during the midst of the depression when the banks were closed. The first thing that comes to mind, Bob, when I look at some of the large banks’ portfolios, particularly the derivatives held by our largest banks, is that they’re looking more like hedge funds than they are a prime safe bank.
BOB: Absolutely. Do you know -- it was actually shocking to me to find out -- that for nearly two centuries, the courts in the United States have upheld an interpretation of bank deposits to mean not money that you’ve delivered for safe keeping but money that you have lent to your bank? That means that if the bank goes under, it’s, “Sorry Charlie. Well, you know, you lent it. It was your risk. Too bad.� You have no recourse. You can’t sue them. They didn’t promise to safe-keep your money. They said, “Thank you for the loan. Now we’ll go out and lend it again and try to make more money than we’re paying you for it.�
The key here is that you need to have your money in a bank that isn’t about to go under because it’s loans are so at risk. Unfortunately, today in the United States, most banks by far have lent out a tremendous percentage of their deposits, in some cases even more than 100% of what they have on deposit. The slightest run or demand by depositors could cause these banks to shut their windows. Now, we all know about the FDIC, and we can talk about that, too, but the point is that these banks are lent out to the hilt. They lent your money out. The only way to get safe is to put your money either in a bank that has extremely high liquidity. And there are a few in the world, a few that exist only to safeguard your money. Or, and I think this would be the second best solution, you can take it out of the banking system and, at least for the time being, lend it directly to the U.S. government by buying Treasury bills.
JIM: I think that’s a lot easier and will probably allow most people to sleep at night. In your book, you talk about physical safety and about the government’s ability to protect you. Certainly, if we look at the social mood, it is changing. It is getting more negative. They’re burning synagogues overseas. We’re seeing the rise of anti-Semitism. You’re seeing it in the movies now with a lot more negative portrayal and more horror movies. Public psychology changes. I wonder if you might address the issue of physical safety.
BOB: Physical safety is important in a bear market. Most people worry about it early in a bull market. For example, in the 1950s, we had bomb drills in school when I was a kid. People were building bomb shelters, they worried about the atomic blasts, and of course we never had anything like it. The reason is that they were concerned about the previous bear market of the 1940s, and they were protecting themselves against the bear wave that had already ended. At this point, we’ve entered a new bear market, very much like being in 1930, and there are going to be extremely difficult times ahead. There will be wars, and you want to make sure that you’re not in a country that’s embroiled in something that could endanger you physically. So I think you need to have a global view, and I think you need to look around and make sure that you’re in the right spot. If you happen to be living in the Middle East, I would look around, for example, at perhaps somewhere else to live. If you’re living in a vulnerable area, you should perhaps decide if there’s some way you could arrange your life to move somewhere safer. Now, some people feel that they can protect themselves by taking a karate class or owning a gun or two because they fear social unrest. But when you look back through the history of these periods, even though occasionally you’ll see urban riots or something like that, most of the time, the risk to one’s person comes when governments get militant. They can turn on their own citizens, or they can fight against another government. Those are the things you really have to watch out for the most.
JIM: I want to talk about the issue of gold because we’ve seen this recent rise in gold. You believe that it’s possible that gold will drop to $200 an ounce. I want you to address those issues because we’ve gotten a lot of e-mails on that one particular point about gold’s going to 200. I would have to say in defense that I could think of two reasons, or two ways, that could happen. Number one, there’s an outright war against gold fought by central banks dumping their reserves. Or number two, in this market crash that you address in your book, a liquidity issue comes up. I can remember buying shares from a hedge fund manager that got caught with a margin call. So, I wonder if you might address the issue of gold in the short-term and longer-term.
BOB: Well, there are two things to consider. One is market opinion and the other is what you should do. They don’t necessarily always follow precisely 100% one with the other, and I’ll tell you what I mean as we go along here. In the depression of the 1930s, silver prices were free to float. Gold was not. It was fixed by the government. Silver had a nice sharp rally in 1931 that lasted most of the year. But by the time the economy bottomed in early 1933, silver had made a new low for the entire preceding fifteen-year period. It bottomed, finally, in December 1932. A lot of people in 1931 thought that silver would be a hedge against the depression. That’s why they bought it, and that’s why it had the rally, but eventually it went down and finally bottomed near stocks. I think that’s likely to happen to all of the precious metals because today, none of their prices are fixed by any government.
What usually happens in a severe deflation is that people have to survive financially. When they’re in tremendous debt, and they have to make that one more payment, they’ll begin to sell things off in order to make the payment. That means selling even things that are valuable. I think that’s one of the reasons why commodities go down and goods go down. It’s going to include the precious metals. However, one important aspect of the metals’ bear market is that most of it has occurred. Except for calling most of the rallies, I’ve been bearish throughout the bear market. This isn’t anything new. Back when gold was at $700 an ounce, I said it’s going to go way down under $400 and maybe eventually under $200. So, that trend is still in force, but look at silver, down from $50 all the way to $4. That is a tremendous bear market. So in one sense, you might say, “Who cares if it’s going to go down to $2.50 or $3.50 an ounce? This is cheap stuff.� So I really recommend that people do own some gold and silver, not only because we’re very late in their bear markets but also because it’s real money. Currently, real money is legal to own. That’s crucial, because when deflation takes hold and depression really gets underway, governments begin to look around for ways to survive, and they’re ruthless when they do it. So, if clamping down on the ability to obtain real money is going to be part of that scenario, you want to make sure that you already have your investments in place. If they don’t allow the transactions, for example, you wouldn’t be able to buy it at that point. Opportunity is an important part of the precious metals picture.
JIM: Now, one thing about the markets -- and of course Elliott Waves track this -- is the psychology that plays such an important role in the financial markets. Part of that is greed, and part is fear. I wonder if we might talk about the fear element because fear to me is a much more powerful emotion. It can drive things more to the extreme. Ultimately, where do you see the markets going? It would be hard for some people, right now, to say that the stock market could lose 90 percent of its value, but that’s exactly what happened during the Great Depression in the 1930s. It wasn’t over with the crash in 1929. Where do you see the stock market going on the downside? And where do you see gold going long-term?
BOB: You’re absolutely right that fear is a stronger emotion than hope. It certainly is more concentrated, which is why it appears stronger. For example, commodities go up on fear. That’s why you have tremendous price spikes in commodities. But stocks go down on fear, and that is the reason that they can fall so precipitously, such as they did in the 1987 crash or the 1929 crash. The key is overvaluation because that is the benchmark that tells you what the risk is. In 1929, the overvaluation was substantial. When we say stocks went down 90 percent, that’s really a complete understatement. What went down 90 percent is the Dow Jones Industrial Average, which was composed of the premier industrial companies of the day. But a huge mass of stocks during that time went down far more than that, by 99% or 100%. People forget about those issues because they don’t know the names anymore. I think we have achieved an overvaluation, as we already discussed earlier, with respect to dividends and the P/E ratio and book value and so on, and it’s far greater than it was at the 1929 high. So I think there is more risk now than we had then. Eventually, as the decline snowballs, feedback will generate more fear until it’s all cleaned out and stocks are the bargain of a lifetime. You know, one thing I hope we can get to before this interview is over is what a tremendous, lifelong, life-saving, opportunity people are going to have at the ultimate bottom. They can only get that if they’ve saved their purchasing power during the bear market.
JIM: Well, what about gold? Where do you see that going?
BOB: Like I say, I was unequivocally negative on gold for 20 years. But last year I published a paper saying that the psychology in gold had turned too negative. This was when it was down at $265 an ounce. I said, “We are either at or approaching the bottom, and the most likely occurrence is an immediate period of rally to be followed by one last leg down, but if I’m wrong, then we’re making the bottom now.� So, I think we’ve had the rally that I’ve talked about, that it was going to occur one way or another. We’re seeing signs right now that gold is getting a little tired. There seems to be a lot of bullishness about it. There is actually vehemence. As you said, if you try to suggest that gold could have another leg down, people scream and argue with you. That generally is not the case early in a bull market. Usually there are a lot of skeptics at that point. So there’s some anecdotal evidence that the scenario of one rally and one final decline, which is exactly what we saw in 1931 and 1932, is on schedule. But I also don’t think it’s that crucial of a question for most people.
If you’re very wealthy, you should have a fair amount of your money in gold and silver. If you’re a speculator, I wouldn’t chase it, unless it got to a point where you couldn’t ignore the fact that a new bull market has started, and that’s at least $70 away on the upside [from $330 today]. So I’m keeping my powder dry as far as getting completely into gold, as I think most people should. As far as how low it can go, I think it could get down to about $180 an ounce, which would be the buy of a lifetime. But we’re running out of time, and I don’t want to be too cute about it. I wasn’t too cute with the stock market. I got out way early because I didn’t want to stay with the crowd, and I don’t want to do the same thing here. Sometimes you can catch a market for 90 percent of it’s move, and if you’re too cute at the end, you miss the turn. So, that’s why, in this book, I say you really should have some gold and silver. It’s real money.
JIM: Let’s talk about the positive side of all of this. If the crash takes place, which I believe is coming, in the depression that follows it, those who are liquid are going to have some of the best buying opportunities of a lifetime. I can think of the story of Warren Buffett's 1968 meeting in La Jolla, California with Ben Graham. Ben Graham had lost half his clients' money during the stock market crash. They were looking at the stock market in the late 1960s, and basically Ben told him to get out. Buffett went back, disbanded his partnership and stayed in cash. But when the ’73/’74 bear market came, he loaded up and bought, I think, what was it, 10% or 20% of The Washington Post for $10 million. He had the buying opportunity of a lifetime, and much of the Buffett fortune was made as a result of that buying.
BOB: That’s right. Then you have stories of the Kennedys and Bernard Baruch and people who did the same thing in 1932. That is when you can make money. If you’re going to buy a stock at $112 a share and hope it goes to $200, that may sound like big money to you, but it’s not. The real money is made when you can buy stocks at 25 cents, a quarter of a point, and watch them go up to $19. That’s real money, and that’s the kind of money that otherwise only super rich people can make. But you can do it only if you’re in cash and you get out at the top and you protect that money all the way down. Then, when the last stock owner despairs, you’ll be his friend by buying those shares from him. At that point, when the market finally turns around, the capital gain multiples are unbelievable. That’s the massive magic of wealth creation in the stock market. But you have to follow the old adage, “Buy low, sell high.� People always forget the “sell high� part.
JIM: In your book you said, in terms of your belief of the coming crash and the depression and deflation that will follow it, that you’re very resolute in your opinion that this is going to happen. I happen to go along with that. But let’s just talk about some of the naysayers that say, "Well yeah, he predicted the bull market, but he got out early. He was wrong by getting out too early." What would you say to your naysayers today?
BOB: Well, I don’t play defense very much, and I always tell people, if that’s important to you, fine. But the real thing people have to understand is this. Anybody who says, “Oh, so-and-so made a mistake,� is pretty much an idiot. It’s like saying, “Joe Smith struck out last week.� You know, this is not a matter of perfection, and anybody who thinks that calling the future is a matter of whether a person is going to be perfect or imperfect doesn’t understand the game. It’s like baseball: It’s a matter of probabilities. Most economists don’t have a clue. They’re telling you what was going on last week and last month. When they tell you what their prediction is, you will see that it’s exactly the same as what the economy has been recently experiencing. They have no tools at all to anticipate the future. I think I’ve got the tools to do a pretty good job, and I think our batting average is very good. I think we’ve been good on most markets. So, people, you’re going to have to pay your money and take your choice. You can listen to the economists. First, you might want to check out their track records for calling recession. I think it would be a good idea to read some of the Elliott wave literature for the last 64 years and decide how well we’ve done overall and compare that to anyone else’s track record. I follow my own advice, but I don’t want to rope people into doing something they’re not comfortable with. I think they need to read the book, and as I say at the very end of the Foreword “Read all the evidence. Then the responsibility is yours.� You make up your own mind one way or another.
JIM: Also, I think in defense, that we can say, look at the track record of economists on the second half recovery and the stock market rise that they’ve been predicting for 3 endless years. Then I would say to anybody listening to this show, look at your portfolio and what’s happened to it. I recommend that they owe it to themselves to pick up a copy of your book and read it because all they hear about on television is bubble vision. It’s rah rah, the stock market’s going up, the economy’s going up. You owe it to yourself, at least, to get the other side's viewpoint. So, Bob, on a worst-case basis, if somebody listened to you and followed your advice by reading this book, they get liquid in cash, what’s the worst that’s going to happen?
BOB: Well, the worst that’s going to happen to average investors is they’ll make 2% or 3%, and that’s if they’re in the safest imaginable instruments. On the other hand, a speculator could make several hundred percent if he’s in the areas that I’m suggesting are going to do well because of a decline. He also assumes risk, but then, if he’s a speculator, that’s his game. Now let’s ask the flip-side question, “What’s the worst that can happen to investors if all these economists are wrong and the market does go down like it did in 1929 and 1932? Well, they’ll be wiped out.
JIM: I think that’s good enough. Bob, unfortunately, we’ve run out of time, but I do want to thank you for joining us on the program. This is a fabulous book. When I read it, I gave it to my wife, who spent a Saturday morning reading it, and I bought three copies for each of my sons.
BOB: Well, that’s great. Would you mind if I put in just a word for where people should order it?
JIM: No, absolutely, let’s do that.
BOB: You can get it at any bookstore, of course. But, if you come to our website, you’ll be able to download the first chapter for free along with a purchase and we put it right through to Amazon’s pricing. It’s the lowest price available anywhere. Anyway, that address is www.elliottwave.com/conquer.
JIM: Bob, speak for a moment about the updates of this book that you’re going to be maintaining at your website.
BOB: Right. We have a site that, once you buy the book, we’ll let you in free for as long as we keep it up, which, I guess, will be at least 2 or 3 years. It’s going to update you on where the safe places for your money are and where the new money-making opportunities are on the downside. In fact, we just got an amazing report on a change in Congressional laws that affect foreign annuities. We’ll be posting that very soon, and I think that’s a good place for some people, at least if you’re in high brackets, to be protecting some of your money. So we’re keeping it up to date. You know, a lot of books go out of date the minute you produce them, and we want to keep this one alive throughout the period.
JIM: Bob, I think you’ve done a great service to the investing public in writing this book. I wish I had written it myself. It’s well documented. If you don’t read this, you do so at your own peril. I want to thank you for joining us on Financial Sense Newshour.
BOB: It’s been a long time since we last talked. Let’s not make it so long until the next one.
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